FDI & FII

Cross-border investments are an important aspect of a country’s capital flow. FDI (Foreign Direct Investment) and FII (Foreign Institutional Investors) are two key terms relating to foreign investments in a country.

Foreign Direct Investment (FDI)

FDI refers to investment by an individual or company from one country into business interests in another country, with the intent to establish a lasting interest and control in the enterprise.

Key characteristics of FDI

• Long-term and Strategic: FDI is generally a long-term investment, where the foreign investor usually takes a significant ownership stake in a company (often defined as 10% or more of equity) or starts a new enterprise (e.g., setting up a subsidiary, joint venture, or acquiring a company).
• Control and Management: FDI investors often have management influence or control in the company. For example, a multinational setting up a wholly-owned subsidiary in India or buying a 51% stake in an Indian company. They may bring in technology, know-how, and management practices along with capital.

Forms of FDI:

• Greenfield Investment: Establishing a new operation from scratch (e.g., a foreign car manufacturer building a new factory in India).
• Brownfield Investment: Investing in or acquiring existing companies (mergers & acquisitions).
• Joint Ventures: Partnering with a local firm to create a jointly owned business.

FDI in Various Sectors

• Different sectors of the economy may allow different levels of FDI. The Indian government sets FDI policy with sectoral caps and conditions:
• Some sectors allow 100% FDI under the automatic route (no prior government approval needed), e.g., manufacturing, many services, infrastructure.
• Some sectors have caps (e.g., Insurance was 74% as of 2021 policy; Defense manufacturing 74% automatic, beyond that up to 100% with approval in some cases).
• Some sensitive sectors like multi-brand retail have caps (51% with conditions), or media (like news media cap 26%), etc.
• A few sectors are prohibited for FDI (like atomic energy, lottery, gambling, etc.).

Routes of FDI:

• Automatic Route: No prior government approval required; just need to notify the RBI (through filings) after investment via authorized dealer bank.
• Government Approval Route: Requires approval from the relevant ministry or a specialized FDI approval body (like earlier FIPB – Foreign Investment Promotion Board – now abolished; now proposals go through DPIIT to respective ministries or Cabinet Committee depending on size).

Regulation

• FDI policy is framed by the Ministry of Commerce and Industry (DPIIT – Department for Promotion of Industry and Internal Trade) and changes are notified via Press Notes. Implementation is under FEMA (Foreign Exchange Management Act) regulations framed by RBI. Thus, both government and RBI/Sebi play roles.

Benefits of FDI:

• Brings capital into the country for development and business growth.
• often brings technology transfer, better management practices, international market access.
• Generates employment and can boost exports (many foreign companies export from India).
• Considered more stable than FII flows since it’s tied up in illiquid assets or long projects (FDI investor can’t pull out money overnight like an FII selling stocks).

FDI in Numbers

• India has been attracting high FDI inflows in recent years (figures around $80 billion annually in mid-2020s). Top source countries include Singapore, USA, Mauritius, etc., and major sectors receiving FDI are services, software/IT, telecommunications, trading, automobile, etc.

Make in India & Ease

• Government initiatives like “Make in India” aim to attract FDI by easing regulations, improving ease of doing business, and building infrastructure.
• Example: If Toyota (Japan) sets up a new car plant in India, that’s FDI (greenfield). If Amazon buys a 49% stake in an Indian retail chain, that’s FDI (brownfield acquisition).

Foreign Institutional Investors (FII) / Foreign Portfolio Investors (FPI)

FII traditionally referred to foreign entities like funds, asset management companies, pension funds, etc., that invest in financial securities of another country (like stocks or bonds), without necessarily seeking control or lasting interest in management.

Important: In 2014, India merged the categories of FII, sub-accounts, and Qualified Foreign Investors (QFIs) into a single category called FPI (Foreign Portfolio Investor) under a new regulation. But in general parlance, FII is still used interchangeably with FPI in many contexts. We’ll use FII/FPI here.

Key features of FII/FPI

• Portfolio Investment: These investors buy stocks, bonds, or other securities in the host country’s capital markets. The intent is to earn returns (dividends, interest, capital appreciation), not to manage or control the companies.
• Short to Medium Term: FPI money is often called “hot money” because it can be moved quickly. If market conditions change or global factors shift, FPIs can sell and withdraw funds rapidly. Thus, FII flows can be volatile month-to-month.
• Examples of FPIs: Foreign mutual funds, sovereign wealth funds, pension funds, hedge funds, foreign banks or insurance companies investing in Indian markets, etc.
• Registration: FPIs must register with SEBI via designated depository participants. They are classified (Category I, II, III) based on type (Cat I includes government and sovereign entities with most favorable terms, Cat II are regulated funds, Cat III are others like hedge funds with more oversight).
• Investment Limits: – FIIs as a whole can invest in up to 24% of the equity of any Indian company by default (sectoral limits also apply). This limit can be raised to the sectoral cap if the company’s board and shareholders approve (many companies have raised the FPI limit to the sector max or even to 100% if allowed).
• Individual FPI: no single FPI should hold 10% or more of equity in a company; beyond that, that investment is reclassified as FDI (substantial influence). – In government bonds, there are separate limits (in rupee terms or percentage of outstanding) that FPIs can invest (RBI sets these). – FPIs cannot invest in small savings, treasury bills beyond certain limit, etc. There are detailed rules by SEBI/RBI.
• Typical FII Investments: Blue-chip stocks, emerging market funds allocate to India, also Indian corporate bonds, government securities (through specific quota known as the Medium-Term Framework, now fully opened in parts via the “Fully Accessible Route” for certain g-secs).

Impact and Significance

FII flows can significantly affect the stock market sentiment and liquidity. Large inflows often drive markets up, outflows can cause corrections. This is watched via monthly net FII figures.

• They contribute to forex inflows on the capital account of Balance of Payments. However, since they can leave quickly, they are less stable than FDI.
• The RBI monitors FII flows in debt because sudden outflows could affect currency stability.

Regulatory aspects

SEBI’s FPI Regulations govern who can register (KYC, etc.).

• Taxation: FPIs in equities are taxed similarly to domestic investors for capital gains (with some treaty benefits if applicable), and in debt interest could be subject to withholding tax.
• Historically, there were “Participatory Notes (P-Notes)”, which were instruments issued by FIIs to other overseas investors to give exposure to Indian stocks without registering as FII. They were controversial due to anonymity. Now P-notes are strictly regulated; only FPIs can issue them to regulated clients and must report.
• FII vs QFI: QFI (Qualified Foreign Investor) was a category introduced in 2012 allowing direct investment by certain foreign individuals in mutual funds and equities, but it was subsumed into FPI in 2014.

Key Differences between FDI and FII (FPI)

Recent Developments / Notes

In recent years, India simplified FDI norms in many sectors (e.g., raised limits in insurance from 49% to 74%, defense up to 74%, allowed 100% in telecom, single-brand retail 100% with conditions, etc.).

Some restrictions came too: e.g., in April 2020, the government made prior approval mandatory for FDI from neighboring countries sharing land border (primarily aimed at China) to curb opportunistic takeovers during COVID downturn. This is an example of policy nuance.

FDI vs FPI question

RBI’s definition (from BoP perspective) is that if a foreign investor holds 10% or more equity in a company, it’s counted as FDI; if less, it’s portfolio investment. This aligns with global standards (IMF). So if an FII buys more than 10%, essentially they become an FDI (also per SEBI rule).

Impact example

If FIIs suddenly pull out (like during global financial crisis 2008, or initial COVID panic 2020), Indian stock markets fell sharply and rupee weakened. Conversely, strong FII inflows (like late 2020, 2021) boosted markets to records. FDI is steadier – even in 2008 crisis, many planned FDI projects still continued though maybe at slower pace.

FPI categories

You might recall old terms: “P-Notes”, “Sub-accounts of FIIs”, etc. but after 2014, they are all FPIs.

Advantages to foreign investors

India offers potentially higher returns (being a growing emerging market) and diversification. But they take currency risk (rupee movement affects their returns). Policies like tax can also influence flows (for instance, when India imposed higher taxes on FPIs in 2019 budget inadvertently, it caused outcry and was later rolled back).

Remittances vs FDI vs FII

These are different flows. Remittances are personal transfers (like NRIs sending money home) – not investment but part of current account. FDI/FII are capital account flows. For perspective, India often runs a trade deficit but it is financed by strong services exports, remittances, AND capital inflows (FDI+FPI). If FPI suddenly reverses, short-term it can stress forex reserves or currency, but strong FDI acts as a stable support.